Best Practices: Developing Budgets

Standardizing the cost management system companywide is an important step in improving the link between cost management and budgeting. Many companies also have found activity-based costing (ABC) helpful in identifying the real cost of producing, selling, and delivering products and services. Even small- to medium-size companies are exploring the potential of ABC, as packaged software becomes more widely available and brings down the cost of engaging in this type of analysis.

Another best practice in linking cost management to budgeting is the strategic use of variance analysis. Variance analysis is the study of differences between budgeted and actual costs, or the study of costs at one company compared with industry averages. By using variance analysis to identify weaknesses, managers can identify areas where their organization needs to improve its performance. But managers must focus on those variances that have a significant impact. Otherwise, decision making and budgeting can become bogged down in trivial detail.

By controlling the number of budgets that are needed and by standardizing budgeting methods, companies take important steps toward streamlining budgeting. Another key step is to minimize the amount of detail included in the reports used to develop budgets. Also, in their effort to streamline budgeting, leading companies use information technology to automate budgeting and facilitate workflow. These companies make sure that budget developers are thoroughly trained in new technologies. This training, together with ongoing monitoring of information needs companywide, helps best practice companies deliver the right information to managers, on time and at the right cost.

Companies typically review budgets quarterly, monthly, or even weekly. By including in these reviews reports on changes in business conditions, companies alert managers that new tactics may be called for, if they are to meet their targets for the year. While it is important that budgets not be revised to cover up for poor performance or poor planning, best practice companies choose to revise budgets rather than adhere to budgets that do not reflect current conditions. Some companies rely on "rolling" or "continuous" forecasts rather than on traditional annual budgets. The chief difference between such forecasts and traditional budgets is that the forecast is updated with actual results as the company moves through the year. Figures for three or more subsequent quarters are projected in decreasing degree of detail.

One way in which companies build flexibility into budgets is to prioritize according to strategic importance action plans that were rejected due to resource limitations. By doing this, they can act swiftly and decisively if additional resources become available.

Another way in which best practice companies develop budgets that accommodate change is to require managers to create scenarios based on a variety of assumptions about business conditions. The affordability of powerful information technology allows for the creation of many "what if" scenarios. This practice makes it possible for companies to respond more quickly and effectively if actual conditions follow the pattern of a particular scenario. Companies also build flexibility into budgets by setting aside funds at the business-unit level to take advantage of competitive opportunities. Some companies even establish separate subsidiaries to look into promising products or technologies.